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Gold is now a speculative investment rather than a safe haven

12th March 2012 Print
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Armstrong Investment Managers (AIM) highlights some of the results from a crossasset study on correlations and volatilities which raise alarm bells for large allocations to gold.

Dr Ana Cukic Armstrong, managing partner of AIM, comments, “Investors’ exposure to gold continues to grow but we believe that more consideration is needed of the risks as well as the benefits. An allocation to gold has served investors very well, but as with all investments that seem to be perfect, when they fail, they fail spectacularly “Although the case for owning gold is very compelling – Western governments are destroying the value of fiat currencies to gain short-term competitive advantages, and monetisation of debt is the inevitable end game for Western central banks and governments – we believe the  risks of gold have now increased.

“Implied gold volatility is the same as equity volatility, and has tracked equity volatility since 2008. Over the long term, equity and gold have shown no correlation in returns. However, over the past three years, correlation between gold and the S&P 500 has risen to almost 0.8. “Gold’s current high correlation with equities, and similar implied volatility, means investors hoping for a diversification benefit from gold holdings may be badly let down. Given what we view as higher risks, we have reduced the weighting in gold in our Diversified Dynamic Solution fund to below 3%, from a high of 11% last year.”

Are we entering a new correlation regime where gold is evolving from a safe haven to a risky asset?

We continue to believe that an allocation to gold makes sense in a diversified portfolio, but investors should not view it as a safe haven without its own inherent risks.

1. The implied volatility of gold is as high as equities

Gold volatility has been as high as equity volatility and tracked equity volatility for many years now. However, gold has not been exposed to a sustained sell off for the past decade, and this has led to complacency from investors. Given its implied volatility, if a sell-off in gold occurred, the magnitude would be similar to the losses suffered by equities in past crises.*

2. The correlation of gold to equities has gone from 0 to 0.8.

Over the long term, gold has been a perfect portfolio diversifier – positive returns with no correlation to traditional asset classes. Over the past three years, gold prices have shown a correlation of 0.8 with the S&P500.*

One of the most striking results of our analysis is that the correlation between gold and silver has declined from 0.86 (between 2004 and 2012) to 0.67 between 2010 and 2012. Recently a portfolio of equities and gold has had less diversification benefits than a portfolio made up of gold and silver holdings.

Dr. Cukic Armstrong concludes, “Investor psychology seems to lead to situations where the asset class that best survived the previous market crash tends to go to an extreme valuation in the following years, moving into a bubble of its own.”

Armstrong Investment Managers LLP (AIM) is a specialist and independent investment boutique focused on delivering inflation beating investment solutions. AIM achieve this by investing in multiple asset classes through a global strategic and tactical asset allocation program supported by our advanced quantitative capabilities and driven by our qualitative discretionary global macro economic views.

Armstrong Diversified Dynamic Solution (DDS) is Armstrong Investment Managers’ flagship multi-asset global macro fund. The broad opportunity set and dynamic flexibility of this fund allows for higher risk adjusted returns than traditional investment approaches. DDS’ aim is to deliver a capital return of at least inflation plus 7% per annum over a 7 year market cycle with no more than 70% of equity Volatility.

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